Joining small business to the global supply chain

Small and medium enterprises are essential components of domestic economies, and adjusting government policies is vital to ensure they have a role to play in the global supply chain, Ganeshan Wignaraja writes.

Moderating growth in developing Asia in 2015 and concerns about rising income inequality have prompted many governments in Southeast Asia to focus on domestic small and medium enterprises (SMEs). Giving into populist pressures, and in a bid to support SMEs, the Philippines and Indonesia, for instance, are considering a panoply of discriminatory policies against foreign enterprises, such as local content requirements, and even industrial policies, such as financial subsidies targeted at specific sectors. However, this is unlikely to support SME development in Southeast Asia.

The latest statistics from these economies suggest that SMEs (defined as businesses with less than 100 workers) make up the bulk of enterprises. They also account for 74 per cent of total employment and 41 per cent of GDP across these economies. Their significance to economic activity in Southeast Asia, however, is not reflected in trade, where they contribute only 21 per cent of direct exports.

Trade itself is no longer just about direct exports or vertically integrated factories in a single country. Today, trade is increasingly about global supply chain trade, with the dispersion of production activities across a geographical space according to least-cost locations and trade in tasks.

Supply chain trade has been an important driver of impressive growth and industrial transformation in Southeast Asia over recent decades.

Rising wages in Japan since the 1980s induced its multinationals to invest in creating automotive and electronics supply chains in Southeast Asia. The emergence of the Peoples Republic of China (PRC) as the global factory, after it became a member of the World Trade Organization in 2001, led to demand for parts and components from Southeast Asia. Blessed with a strategic geographical location and cheap, literate labour, Southeast Asian economies pursued outward-oriented development strategies.

Singapore, Thailand and Malaysia emphasised attracting export-oriented foreign direct investment using incentives, export processing zones and investment promotion. Others in Southeast Asia followed suit. These developments enabled Southeast Asia to achieve a respectable 9 per cent share of world supply chain exports in 2013.

Moderating growth in developing Asia, however, means that Southeast Asian economies face heightened competitive pressures and may risk being marginalised in supply chains in the future. Competition is intensifying in supply chains from the major Asian players, such as the Peoples Republic of China, Korea and Japan, and emerging India and several Latin American economies.

Adjusting business strategies and national policies is critical for expanding Southeast Asia’s role in supply chain trade. The size of firms matters when joining supply chain trade – being a big firm naturally creates advantages to participating in supply chains, due to a larger scale of production, better access to technology from abroad, the ability to pay higher wages for skilled labour and to spend more on marketing. Smart business strategies, such as mergers, acquisitions and forming business alliances with multinationals or large local business houses, are rational approaches.

Under some circumstances, nimble SMEs can also join supply chains. By clubbing together in industrial clusters, SMEs can overcome some of the disadvantages of being small and rely on the benefits of interdependence. For instance, small firms located in clusters can jointly finance a training centre or a technical consultant to upgrade skills. Business associations can facilitate clustering by mitigating trust deficits to cooperation among SMEs, and by coordinating collective actions for cluster formation. For instance, major industrial clusters are located in Vietnam near Hanoi and Ho Chi Minh City, where large firms are surrounded by thousands of SME suppliers and subcontractors making garments, agricultural machinery and electronics goods.

The national policy environment – which consists of myriad incentive and supply side interventions (such as investing in physical infrastructure, upgrading education and training, and support from technology institutions) – also matters for SMEs in supply chains in Southeast Asia.

The coverage and quality of business support services counts. The better and more affordable the type of technical, marketing and professional services SMEs have around them, the more the chances they grow and enter supply chains. A sound and effective financial system (with specialist financial products and institutions) is crucial. Modern and cost competitive physical infrastructure – particularly transport, telecommunications and electricity – is another. Finally, open trade and investment regimes which transmit price signals and induce competition are important. So too is streamlining procedures to business start-up and operation.

More controversial perhaps is resorting to industrial policies to support the entry of particular sectors or SMEs into supply chains. The experience of Asia, including Southeast Asia, is replete with some successes and many costly failures in the use of industrial policies. Some examples include Korea’s Heavy and Chemical Industry push, Malaysia’s National Car Project (the Proton Car) and the Peoples Republic of China’s home grown 3G mobile Technology (TD-SCDMA). More research is needed on what works and what does not, as there is a high risk of government failure associated with the application of industrial policies.

There is no one-size-fits-all approach to helping SMEs to join supply chains in Southeast Asia. Smart business strategies, facilitating business associations and supportive national policies are all useful ingredients, while SMEs and governments working together is essential to tailor these ingredients to national circumstances.